Can a 529 Plan Help with Estate Planning? By Austin Estate Planning Attorney Zachary D Kamykowski

Parents and grandparents use 529 education savings plans to help with college expenses. However, according to a recent article, “Reap The Recently-Created Planning Advantages Of 529 Plans,” from Forbes, they are also a good tool for estate planning.

There’s no federal income tax deduction for contributions to a 529 account. However, 35 states provide a state income tax benefit—a credit or deduction—for contributions as long as the account is in the state’s plan. Six of those 35 states provide income tax benefits for contributions to any 529 plan, regardless of the state of origin.

Determining how much you should save for college depends on where you think your child or grandchild might be happy - and get into. Whether you are saving for UT, A&M, or Rice, you should start doing so as soon as possible. Along with the uncertainty of inflation, you also must contend with the uncertainty in the performance of your investment accounts. As an Austin Estate Planning Attorney, I can help you answer these questions as part of a comprehensive Wealth Plan.

Contributions also receive federal estate and gift tax benefits. A contribution qualifies for the annual gift tax exclusion, which is $16,000 per beneficiary for gifts made in 2022 ($17,000 for 2023 gifts). Contributing up to this amount avoids gift taxes and, even better, doesn’t reduce your lifetime estate and gift tax exemption amount.

The benefits don’t stop there. If it works with the rest of your estate and tax planning, you can use up to five years’ worth of annual gift tax exclusions with 529 contributions in one year. You may contribute up to $80,000 ($85,000 in 2023) per beneficiary without triggering gift taxes or reducing your lifetime exemption.

You can, of course, make smaller amounts without incurring gift taxes. However, if this size gift works with your estate plan, you can use the annual exclusion for a grandchild for the next five years. This move can remove a significant amount from your estate for federal estate tax purposes.

While the money is out of your estate, you still maintain some control over it. You choose among the investment options offered by the 529 plan. You can also change the account’s beneficiary to another family member or even to yourself if the funds go towards qualified educational purposes.

The accumulated income and gains will be taxed and subject to a 10% penalty, but the original contribution is not taxed or penalized. The money can be withdrawn from a 529 account if needed or if it becomes clear the beneficiary won’t use it for educational purposes. It may be better to change the beneficiary if another family member is more likely to need it.

As long as they remain in the account, investment income and gains earned compound tax-free. Distributions are also tax-free as long as they are used to pay for qualified education expenses.

In recent years, the definition of qualified educational expenses has changed. When Congress first created these accounts, many 529s did not permit beneficiaries to spend money on computers and internet fees. Today, beneficiaries can use the funds for computers, room and board, required books and supplies, tuition, and most fees.

The most recent expansion is that beneficiaries can use 529 to pay for a certain amount of student debt. However, if one uses the funds to pay interest on a loan, the interest is not tax deductible.

Finally, a 2021 law made it possible for a grandparent to set up a 529 account for a grandchild, and distributions from the 529 account do not count as income to the grandchild. This is important when students are applying for financial aid; before this law changed, the funds in the 529 accounts would reduce the student’s likelihood of getting financial aid.

Two factors to consider: which state’s 529 is most advantageous to you and how you can use it as part of your estate plan. I invite you Book a Call so we can discuss your specific circumstances.

Reference: Forbes (Oct. 27, 2022) “Reap The Recently-Created Planning Advantages Of 529 Plans”